Kahneman’s Time Interview Fails to Allay Concerns About Behavioral Law and Economics

Thom Lambert —  28 November 2011

TOTM alumnus Todd Henderson recently pointed me to a short, ten-question interview Time Magazine conducted with Nobel prize-winning economist Daniel Kahneman.  Prof. Kahneman is a founding father of behavioral economics, which rejects the rational choice model of human behavior (i.e., humans are rational self-interest maximizers) in favor of a more complicated model that incorporates a number of systematic irrationalities (e.g., the so-called endowment effect, under which people value items they own more than they’d be willing to pay to acquire those same items if they didn’t own them). 

 I’ve been interested in behavioral economics since I took Cass Sunstein’s “Elements of the Law” course as a first-year law student.  Prof. Sunstein is a leading figure in the “behavioral law and economics” movement, which advocates structuring laws and regulations to account for the various irrationalities purportedly revealed by behavioral economics.  Most famously, behavioral L&E calls for the imposition of default rules that “nudge” humans toward outcomes they’d likely choose but for the irrationalities and myopia with which they are beset.

 I’ve long been somewhat suspicious of the behavioral L&E project.  As I once explained in a short response essay entitled Two Mistakes Behavioralists Make,  I suspect that behavioral L&E types are too quick to reject rational explanations for observed human behavior and that they too hastily advocate a governmental fix for irrational behavior.  Time’s interview with Prof. Kahneman did little to allay those two concerns.

Asked to identify his “favorite experiment that demonstrates our blindness to our own blindness,” Prof. Kahneman responded:

It’s one someone else did.  During [the ’90s] when there was terrorist activity in Thailand, people were asked how much they’d pay for a travel-insurance policy that pays $100,000 in case of death for any reason.  Others were asked how much they’d pay for a policy that pays $100,000 for death in a terrorist act.  And people will pay more for the second, even though it’s less likely.

 This answer pattern is admittedly strange.  Since death from a terrorist attack is, a fortiori, less likely than death from any cause, it makes no sense to pay the same amount for the two insurance policies; the “regardless of cause” life insurance policy should command a far higher price.  So maybe people are wildly irrational in comparing risks and the value of risk mitigation measures.

 Or maybe, as boundedly rational (but not systematically irrational) beings, they just don’t want to waste effort answering silly, hypothetical questions about the maximum amount they’d pay for stuff.  I remember exercises in Prof. Sunstein’s class in which we were split into groups and asked to state either how much we’d pay to obtain a certain object or, assuming we owned the object, how much we’d demand as a sales price.  I distinctly recall thinking how artificial the question was.  Given the low stakes of the exercise, I quickly wrote down some number and returned to thinking about what I would have for lunch, what was going to be on Sunstein’s exam, and whether I had adequately prepared for my next class.  I suspect my classmates did as well.  Was it not fully rational for us to conserve our limited mental resources by giving quick, thoughtless answers to wholly hypothetical, zero-stakes questions?

If so, then there are two possible reasons for subjects’ strange answers to the terrorism insurance questions Kahneman cites:  Subjects could be wildly irrational with respect to risk assessment and the value of protective measures, or they might rationally choose to give hasty answers to silly questions that don’t matter.  What we need is some way to choose between these irrational and rational accounts of the answer pattern.

Perhaps the best thing to do would be to examine people’s revealed preferences by looking at what they actually do when they’re spending money to protect against risk.  If Kahneman’s explanation for subjects’ strange answers were sound, we’d see people paying hefty premiums for terrorism insurance.  Profit-seeking insurance companies, in turn, would scramble to create and market such risk protection, realizing that they could charge irrational consumers far more than their expected liabilities.  But we don’t see this sort of thing.

That suggests that the alternative, “rational” (or at least not systematically irrational) account is the more compelling story:  Subjects pestered with questions about how much hypothetical money they’d spend on hypothetical insurance products decide not to invest too much in the decision and just spit out an answer.  As we all learn as kids, you a ask a silly question, you get a silly answer.

So again we see the behavioralist tendency to discount the rational account too quickly.  But what about the second common behavioralist mistake (i.e., hastily jumping from an observation about human irrationality to the conclusion that a governmental fix is warranted)?  On that issue, consider this portion of the interview:

Time:  You endorse a kind of libertarian paternalism that gives people freedom of choice but frames the choice so they are nudged toward the option that’s better for them.  Are you worried that experts will misuse that?

Kahneman:  What psychology and behavioral economics have shown is that people don’t think very carefully.  They’re influenced by all sorts of superficial things in their decisionmaking, and they procrastinate and don’t read the small print.  You’ve got to create situations so they’ll make better decisions for themselves.

Could Prof. Kahneman have been more evasive?  The question was about an obvious downside of governmental intervention to correct for systematic irrationalities, but Prof. Kahneman, channeling Herman “9-9-9” Cain, just ignored it and repeated his affirmative case.  This is a serious problem for the behavioral L&E crowd:  They think they’re done once they convince you that humans exhibit some irrationalities.  But they’re not.  Just as one may believe in anthropogenic global warming and still oppose efforts to combat it on cost-benefit grounds, one may be skeptical of a nudge strategy even if one believes that humans may, in fact, exhibit some systematic irrationalities.  Individual free choice may have its limits, but governmental decisionmaking (executed by self-serving humans whose own rationality is limited) may amount to a cure that’s worse than the disease.

Readers interested in the promise and limitations of behavioral law and economics should check out TOTM’s all-star Free to Choose Symposium.

 

Thom Lambert

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I am a law professor at the University of Missouri Law School. I teach antitrust law, business organizations, and contracts. My scholarship focuses on regulatory theory, with a particular emphasis on antitrust.

7 responses to Kahneman’s Time Interview Fails to Allay Concerns About Behavioral Law and Economics

  1. 

    At the risk of beating a (possibly dead) red herring, the author’s description of his response to Prof. Sunstein’s class reveals nothing but inherent bias:

    “I remember exercises in Prof. Sunstein’s class in which we were split into groups and asked to state either how much we’d pay to obtain a certain object or, assuming we owned the object, how much we’d demand as a sales price. I distinctly recall thinking how artificial the question was. Given the low stakes of the exercise, I quickly wrote down some number and returned to thinking about what I would have for lunch, what was going to be on Sunstein’s exam, and whether I had adequately prepared for my next class. I suspect my classmates did as well. Was it not fully rational for us to conserve our limited mental resources by giving quick, thoughtless answers to wholly hypothetical, zero-stakes questions?”

    Zero-stakes? Did it not occur to you that Prof. Sunstein was evaluating the class not on the specific numbers you all wrote but on your attitudes, and that the spread of answers would reveal that some took the exercise seriously but others did not? Or that “thoughtless” written answers lead to thoughtless oral answers, and most law professors are smart enough to identify the latter? And in any case, why was the question artificial? If you owned a work of art left to you by your parents, for example, you might well demand a very different price to sell it than the price you would pay if you did not own it and it were offered to you to purchase.

    This aspect of your criticism undermines your larger points.

  2. 

    Exceptionally uncompelling argument that is poorly thought out and even more poorly researched. If the explanation regarding the finding of irrationality in these studies is that people aren’t thinking about their answers: “Was it not fully rational for us to conserve our limited mental resources by giving quick, thoughtless answers to wholly hypothetical, zero-stakes questions?”, then the differences in the values they assign to the two different conditions in these studies should be random. It is not. In study after study after study in group after group after group, it is not.

    Second, some of these studies have been performed in situations in which the stakes do matter, in fact, they matter a lot. One such study was done in India, where the reward for optimal performance was several months salary. It again confirmed that standard economic models don’t predict how humans will behave. Is Mr. Lambert suggesting that a situation involving several months salary is zero-stakes?

  3. 

    You argue: “If Kahneman’s explanation for subjects’ strange answers were sound, we’d see people paying hefty premiums for terrorism insurance…But we don’t see this sort of thing.”

    I don’t think this is right. Consider, for instance, life insurance sold at airport kiosks — a highly profitable line of business even though the product is pretty terrible. Alternatively, and in much the same vein, consider life insurance on children (which involves a highly salient risk, but is also generally a quite unwise investment).

    This is not to say that I disagree with your point that behavioralists are too quick to dismiss rational actor accounts. I think this is often true. But, to be honest, I think exactly the inverse can be said of traditional law and econ folks — that they are too quick to reject behavioral explanations. In other words, we are all too quick to explain the world in ways that are consistent with our preexisting worldview.

    Which, ironically enough, is itself the confirmation bias!

    • 

      Not to mention, to extend the irony further, perfectly consistent with rational choice models of economic behavior. It does not require confirmation bias for incumbents and new entrants to have ample incentives to dismiss the merits of the others’ products. Of course, that doesn’t mean its useful scholarship to do so. A simple but required step to move forward in these debates is to take seriously the methodological commitments — namely, that the superiority of competing models is to be determined empirically, i.e. predictive power in the relevant setting — shared by both behavioral and traditional L&E scholars. In my view the existing legal literature relying upon BE insights provides little reason to be optimistic on this front.

  4. 

    Prof. Lambert – Your criticism of law and behavioral economics is well said. I have yet to read any response anywhere to the points you make about the flawed rationality of government regulators.

    For me, Basic is the defining case. The behaviorists are happy to point out in article after article all the irrationalities that beset investors. Efficient markets? They scoff – investors are sheep, they have endowment biases, etc., etc., etc. But ask the behaviorists if they think Basic was wrongly decided and you get a different response. That suggests that to me a lot (although obviously not all) of the enthusiasm for law and behavioral economics is instrumental and unprincipled.

  5. 

    Stating that you did not pay attention to Sustein’s class (preferred to thing about your lunch) and saying that his questions and Kahnemann’s (on which his impacting work, that guaranteed him a Nobel prize, is based) are silly is kind of disrespectful.

  6. 

    I was in the thick of things when libertarians first began to respond to Sunstein and Thaler’s thesis in NUDGE. The book was harshly criticized, and many scholars wrote very long journal articles attacking the arguments presented in NUDGE. In particular, Mario Rizzo, who is an EXTREMELY capable scholar in his own right, has wasted many, many hours attacking “libertarian paternalism.” Personally, I think his energy could have been better spent elaborating on the economics of “time and ignorance.” But he seems to be really interested in criticizing libertarian paternaism.

    For my own part, I thought the NUDGE book was actually quite good. I think it illustrated quite well many flaws of the Libertarian ideology. For example, Sunstein and Thaler spend a great deal of time on what they call the “choice environment.” In their view, no choice framework is every truly *neutral*, and in that sense no act of personal and consumer behavior is ever truly *autonomous*. In other words, there is NO NEUTRAL WAY to frame the environment in which choices are made. This, in my view, is devastating to libertarianism, which stands for sovereignty from any outside influence (especially government). So, there is no such thing as consumer sovereignty or a neutral market.

    Now an ancillary thesis to this argument is that private markets HAVE recognized the existence of non-neutrality (and the concomitant manipulability of consumer behavior) and have proceeded to exploit this to their own advantage. That is why Sunstein and Thaler advocate an increased role for government intervention — The basic idea behind this book is that “social nudging” should try to offset (and possibly eliminate) the efforts of private companies in manipulating the the “humanness” of individual decision-making.

    So, in short, I think NUDGE is right in the non-neutrality of “choice environments.” My criticism concerns rather the ability of *entrepreneurs* to successfully manipulate individual (consumer) behavior. I think that is far too charitable an interpretation of how markets work. Many businesses fail, and many investments turn out to be incorrect. Once we recognize the fallibility of private market actors, we will then be in a better position to recognize the fallibility of government bureaucrats and regulators. That is how the argument, in my view, should be made. It seems silly to challenge NUDGE on the grounds that choice environments are actually neutral.